Georgetown University Law Center Georgetown University Law Center
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2010
Systemic Regulation of Global Trade and Finance: A Tale of Two Systemic Regulation of Global Trade and Finance: A Tale of Two
Systems Systems
R. Michael Gadbaw
Georgetown University Law Center
, rmg57@law.georgetown.edu
Georgetown Public Law and Legal Theory Research Paper No. 11-35
Georgetown Business, Economics and Regulatory Law Research Paper No. 11-07
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13 J. Int'l Econ. L. 551-574 (2010)
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SYSTEMIC REGULATION OF GLOBALTRADE
AND FINANCE: A TALE OF TWO SYSTEMS
R. Michael Gadbaw*
ABSTRACT
The recent financial crisis has put enormous strains on the global systems
governing international finance and trade. These two important international
regulatory systems, created after World War II to promote growth and sta-
bility in the global economy, were put to the test in ways unprecedented
since the 1930s. This article seeks to analyze and compare their performance
as systemic regulators in the course of the crisis and concludes that the
trading system performed quite well while the financial system virtually col-
lapsed. This article seeks to account for this difference by looking at the
nature of the rules and the institutions governing each and how they evolved
so differently over the past 70 years. Central to the success of the World
Trade Organization (WTO) is a regulatory approach that includes rules de-
signed, and tested in practice, to align incentives with the public good and
prevent regulatory capture and a self-enforcing dispute settlement mechan-
ism that ensures accountability and enforceability. The article concludes that
these differences hold important lessons for the reform of the rules and
institutions governing finance and trade in the global economy, and the
role the WTO should play in this reform.
I. TRADE AND FINANCE: THE TWIN PILLARS OF SYSTEMIC
REGULATION OF THE GLOBAL ECONOMY
A. Nat ure or nurture?
The interplay of two global regulatory systems—finance and trade
1
—
deserves scrutiny in our thinking about the crisis of 2007–09 with respect
* Adjunct Professor, Georgetown University Law Center; Distinguished Senior Fellow, Institute
for International Economic Law. In the interest of full disclosure, note that this article draws
on the author’s experience working in international economic law: in the White House
(summer of 1973); in the Treasur y Department and the Office of the US Trade
Representative (1975–80); in private law firms (1980 to 1990) representing, among others,
the semiconductor and computer industries; as Vice President and Senior Counsel of General
Electric (1990 to 2008). E-mail: mgadbaw@verizon.net
1
The interplay of trade and finance is as old as economic history itself. See William J. Bernstein,
A Splendid Exchange; How Trade Shaped the World (New York: Atlantic Monthly Press, 2008)
18: ‘First, trade is an irreducible and intrinsic human impulse, as primal as the needs for food,
shelter, sexual intimacy, and companionship. Second, our urge to trade has profoundly affected
Journal of International Economic Law 13(3), 551–574
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to what happened, the underlying causes, and how to identify and implement
reforms that will mitigate or prevent crises of this magnitude in the future.
Parallels to the Great Depression have been drawn as analysts, policymakers,
regulators, politicians, and the general public try to develop a narrative to
explain the events that reverberated across national borders to virtually every
corner of the globe, utilizing the channels of globa lization to spread the
impact and threatening to undo many of the benefits (wealth, economic
growth and asset values) to which trade and capital flows have been so in-
strumental. This article seeks to contribute to this dialogue by comparing and
contrasting the way the global financial system and the global trading system
performed as systemic regulators through the crisis. The argument will be
made that the dramatic differences in the way each of these performed, with
the collapse of the financial system while the trading system experienced only
a minor disruption, can be attributed to important differences in their under-
lying regulatory systems as reflected by their respective institutions, the rules,
dispute settlement and enforcement mechanisms. Ultimately, we find two
profoundly contrasting regulatory paradigms for trade and finance, reflecting
underlying differences in market dynamics and policies regarding the inter-
action of markets and rules. How did these mutually interdependent systems
evolve side by side in such dramatically different directions?
The importance of this debate should not be underestimated. Although
the global economy is recovering from the worst of the asset declines in
housing, household wealth and financial institution solvency, the question
remains whether the global economy can recover in the absence of a greater
sense of confidence among investors, consumers, employers and employees
that comparable crises can be avoided or at least mitigated in the future.
Moreover, can the global economy function properly when the two systems
of trade and finance seem so out of synch in terms of the quality of their
regulatory frameworks and the strains that must be absorbed by one when
the other fails to carry its weight in maintaining the stability of the overall
system.
B. Systemic performance—finance and trade— crisis to crisis
The totality of the collapse in our global economy, attributed in part to
economic polic ies and regulatory failures, has led us to take a system wide
view of causes and effects. Systemic failure and its counterparty systemic risk
have entered our public policy lexicon. This kind of top down preoccupation
has its historical parallels. The Great Depress ion prompted a rethink of our
economic policies and the adoption of Keynesian intervention to promote
the trajectory of the human species.’ See also Niall Ferguson, The Ascent of Money: A Financial
History of the World (New York: The Penguin Press, 2008) 2: ‘Despite our deeply rooted
prejudices against ‘‘filthy lucre’’, however, money is the root of most progress.’
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full employment and economic growth. Internationally, Lord Keynes and his
colleagues seized the opportunity in the aftermath of the World War II
to create the Bretton Woods tr iumvirate, comprising the International
Monetary Fund (IMF), the World Bank, an d the General Agreement on
Tariffs and Trade (GATT), to bring countries together in a comprehensive
set of international institutions based on the rule of law and the principles of
free trade and economic integration.
2
The series of financial crises over the
ensuing decade s—starting with the US decision to abandon the gold stand-
ard in the early 1970s ,
3
followed by the Russian and Latin Amer ican crises
of the 1990s, and the Asian crisis of 1998—actually reinforced the view that
the system, as it had evolved at those times, was sound and could be man-
aged, by the likes of the Committee to Save the World,
4
to handle the
occasional crisis.
Now we find ourselves thinking once again about systemic failure, systemi c
risk and systemic regulation. Systemic risk is generally used only in connec-
tion with financial regulatio n to refer to ‘a problem with payment or settle-
ment systems or ...some type of financial failure that induces a
macroeconomic crisis’.
5
For reasons explained more fully below, the concept
is used here more broadly to encompass a failure of any major pillar of our
global economy, including trade and finance, which leads to a macroeco-
nomic cr isis. Including the trading system as a source of systemic risk is
consistent with our historical experience in the 1930s when protectionism
was an important factor in the cause, depth, and length of the Great
Depression. Moreover, this perspective al lows us to consider the policies
and institutions that have led us, perhaps too easily, to take for granted
the notion that trade cannot be a source of macroeconomic failure.
In the 1930s, what started as a financial crisis with a run on the banks,
also turned into a full-blown economic crisis and more than a decade of
depressed economic growth, notwithstanding a complete shift in the para-
digm for government intervention from laissez faire to Keynesian
2
For an excellent review of the origins of Bretton Woods and the challenges facing the system in
the aftermath of the financial crisis, see Richard N. Gardner, ‘The Bretton Woods-GATT
System after Sixty-five Years: A Balance Sheet of Success and Failure’, 47 Columbia Journal
of Transnational Law 26 (2008), at 27; see also the paper by Andreas Lowenfeld in this issue
at 575–595.
3
One of the key linkages between trade and finance has been the use of trade measures for
balance of payments reasons, the most significant case of which was the 10% import surcharge
imposed by President Nixon in 1971. See John H. Jackson, William J. Davey and Alan O.
Sikes, Jr., Legal Problems of International Economic Relations (5th edn St. Paul, MN: Thomson
West, 2008) 1098–109.
4
This reference comes from the cover of Time, 15 February 1999, http://www.time.com/time/
covers/0,16641,19990215,00.html (visited 3 August 2010) which featured Robert Rubin,
Lawrence Summers and Alan Greenspan for their work in the aftermath of the Asian financial
crisis.
5
Kern Alexander, Rahul Dhumale and John Eatwell, Global Governance of Financial Systems; the
International Regulation of Systemic Risk, (Oxford: Oxford University Press, 2006) 24.
Systemic Regulation of Global Trade and Finance 553
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intervention. The critical point for our pur poses is the way the trading
system performed as a result of the passage in 1930 of the Smoot-Hawley
Tariff Act,
6
which erected insurmountable tariff barriers on goods coming
into the USA and reduced both the value and the volume of international
trade with the USA by as much as 50%. Not only did this intervention
account for a ver y h igh percentage in the decline in trade, as distinct from
the fall in demand, but this intervention was mimicked by other countries
that erected similar barriers around the globe, the cum ulative result of which
was to exacerbate the depression and block a critical avenue for post-crisis
recovery.
The contrast with the crisis of 2007–09 is striking. While there was a
decline of around 18% in the peak-to-trough value of international trade
in the first year of the crisis, that decline was virtually ent irely the result of
a decline in demand, not of government intervention.
7
Under the scrutiny of
global institutions and private trackers, the government interventions were of
minor consequence; less than 1% of global trade by some accounts.
8
In the
second year after the crisis (201 1), global trade is expected to grow at a rate
of over 9%; and for many countries, not least the USA, international trade is
seen as one of the critical channels for economic recovery.
9
In contrast to the trading system, which performed well throughout the
crisis, the financial system seems to have failed in fundamental ways across
the spectrum of monetary policy and prudential supervision.
10
6
United States: Tariff Act of 1930, Act of June 17, 1930, 46 Stat. 685.
7
The performance of the WTO in the course of the crisis has been ably analyzed in Brendan
Ruddy, ‘The Critical Success of the WTO: Trade Policies of the Current Economic Crisis’,
13(2) Journal of International Economic Law 287 (2010) 475–95. Ruddy looks at the eco-
nomic literature and the tracking systems that document and measure the effect of protec-
tionist measures and concludes: ‘unlike the trade restrictive measures of the Great Depression,
measures taken during the current economic crisis have not materially contributed to the
decline in trade volume and GDP’. This conclusion is also supported by the WTO’s own
analysis.
8
Ibid, fn 48 and accompanying text.
9
For a ver y thorough analysis of the failure of protectionism to manifest in the course of the
recent crisis, with a very low-key endorsement of the WTO’s role, see Simon J. Evenett,
Bernard M. Hoekman and Olivier Cattaneo (eds), Effective Cr isis Response and Openness:
Implications for the Trading System (Washington, DC: World Bank and Center for Economic
and Policy Research, 2009), at 5. The countries that were most protectionist in their re-
sponses were not members of the WTO (Algeria and Russia) (p. 5).
10
To assist the reader, the primary sources for this description of the crisis are collected here.
For a first hand account of the collapse of Lehman Brothers and the ensuing collapse of the
financial markets, see Andrew Ross Sorkin, Too Big to Fail (New York: Viking, 2009). Michael
Lewis has looked at the small group of hedge fund managers who saw the coming crisis and
took advantage of it by betting against it in Michael Lewis, The Big Short: Inside the Doomsday
Machine (London: Allen Lane, 2009). Nassim Nicholas Taleb has looked at the role of fi-
nancial models for valuing assets and risks and how these models miscalculated the probabil-
ity of events with catastrophic consequences in Nassim Nicholas Taleb, The Black Swan: The
Impact of the Highly Improbable (New York: Random House, 2007). Richard A. Posner docu-
ments his own conversion from a Chicago school critic of excessive financial regulation to a
more pragmatic advocate for the proper balance of regulations and the market in a capitalist
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